Central Banks Can Save DeFi, as Weird as That Sounds

Ayn Rand’s followers dreamed of decentralized finance as the ultimate realization of their techno-anarchist utopia: freedom from both governments and large custodial organizations. But somewhere along the way, they got stuck on George Orwell’s Animal Farm where some animals are more equal than others.

Much of what passes as DeFi today is just “decentralization theater,” as Fabian Schar, a University of Basel professor of blockchain, describes it. In theory, this hot new crypto corner wasn’t envisioned to be controlled by big-bulge intermediaries. The self-executing computer code deciding how digital assets would be lent or invested was supposed to be impervious to manipulation. Developers weren’t expected to have special rights.

The reality has turned out to be different: From backdoors to kill switches, discretionary power is concentrated in a few players. You even have to pay for protection from “sandwich attacks” that place one transaction before and another after yours on the blockchain to steal your profit. The distributed ledger technology was supposed to leave all this Wall Street chicanery behind. But if a big chunk of DeFi has moved far away from its original vision, why not at least make it safe for all users by introducing the biggest centralizing force of conventional finance? The central bank.

Central bank digital currencies, or CBDCs, are in various stages of experimentation, partly as an answer to stablecoins. These private tokens peg their value to an official unit of account (such as the dollar), giving crypto investors a less volatile pathway than Bitcoin or Ether. Stable, however, doesn’t mean safe. To the extent stablecoins invest in risky assets, it’s natural for the Bank for International Settlements — the bank for central banks — to investigate if these tokens are really needed for DeFi liquidity. Letting people buy digital assets with CBDCs, which are direct claims on monetary authorities, will eliminate threats to financial stability from a stablecoin going bust.

“Does Safe DeFi Require CBDCs?” was the topic of a recent conference held in Zurich by the BIS and the Swiss National Bank. In his presentation, Schar answered the question with an emphatic “no.” DeFi relying on central banks would be a paradox. “It’s like asking, ‘Does safe decentralization need centralization?’” he said. But that doesn’t mean that monetary authorities can’t do some good. “Could a CBDC in a DeFi ecosystem be mutually beneficial? That’s a much more interesting question,” Schar said.